For the New Year, let’s go back to the basics and see what the markets are pricing in for the FOMC in 2018.  The most common refrain I hear is “three hikes in 2018.”  I can see that.  There appears to be more “smoothing” on the Fed Fund meeting curve than I remember.  What are the odds that the March, June, Sept and Dec Fed meetings all fall on a straight line?  I’m not sure the meetings should be this orderly in a potentially volatile year.  I mentioned last week how straight the one year fly curve was last week.  There are times to smooth, but the FF curve on near-term hikes shouldn’t be one of them.  There are too many time-dependent factors to smooth the curve.

  • January 2018. The Fed just hiked.  This is Yellen’s last meeting as the lame duck Chair.  So having zero priced in makes sense.  I think at some point, someone may want to pay 0.25 or 0.5 bps for the Jan meeting as a lottery play (or protection).  But with the FFER potentially not being stable, I’m not so sure taking a position in FFF8 and FFG8 makes sense.
  • March 2018. This is an extremely interesting meeting.  The data has been strong, equites are on fire, we just got fiscal tax stimulus and we may be getting some infrastructure stimulus.  So almost 80% is not unreasonable.  We are “data dependent,” so it’s hard to price in that much more with over two months to go.  However, I think the odds of a skip in March are “slightly larger than normal” for the following reasons:
    • Powell will be the new Chair. I can see how Powell may be on the side of policy normalization with all the positive news we have been getting.  But isn’t it possible he gets some kind of Trump “loyalty” nudge to let the economy run hot?  A guy gets a job nod from a buddy and his first action as Fed Chair is to snuff out the benefits of his buddy’s tax reform.  This seems a little cold in Trump’s old-boy network world, no?  Oh… but the Fed is supposed to be independent!
    • We have this crazy weather. I’m not sure how long it lasts, but this could depress some economic data.  Who is to say we couldn’t get another winter storm, like with the hurricanes?  These may not be uncorrelated events.  The Fed could just dismiss this as being seasonal noise since Q1 data has typically been depressed.  But weather could be a minor factor.
    • Last March, core PCE printed 0.3 mom (for Jan 2017). When this rolls off the yoy core PCE rate could decline.  The Fed’s going to know this.  But on the margin, couldn’t having the yoy PCE rate dip a few weeks before a hike look a little “aggressive”?
    • Once the infrastructure plan and repatriation occur, I think stocks could be vulnerable. Buy on the rumor sell on the fact?
    • Any negative side effects of the tax plan could start showing up in another month or two. I’m not saying they will show up.  But people seem oblivious of the tails.
  • May 2018. Some 1s finally started trading in FFJ8-K8 spread.  Just as it is hard to see a Jan hike after a hike in December, it’s hard to see a May hike after a hike in March.
  • June 2018. I think the markets could eventually gravitate towards a June hike, on a relative  In a vacuum, if you tell someone “two hikes in 2018” (as the market is pricing in), you naturally will gravitate towards June and Dec – especially after a Dec 2017 hike.  On an absolute basis, 15bps seems about fair.
  • August 2018. I have no idea why the markets are pricing in 2-2.5bps for the August meeting.  Again, after a June hike, this will probably go to zero.  I suppose you could conjure up some scenario where the Fed skips in June, and hikes in August because September is too close to the election.  However, that makes no sense when September is 11bps (and looks too high relatively), and on a straight line to the rest of the meetings.
  • September 2018. This could also be an interesting meeting, because it’s the meeting right before the elections, and there is a chance the Republicans could lose the House.  Could this be time for another “loyalty” nudge?  Oh… but the Fed is supposed to be independent!
  • November 2018. This is the first meeting after the elections.  I suppose if the Fed held off in September on a close call, this meeting could come into play.  However, I think a more likely candidate would be…
  • December 2018. This seems like a more likely candidate for a Fed hike.  But if a gorilla is out there smoothing the FF quarterly meeting curve, it may take a while for this to move.  Let’s keep it on the radar.  Call me a simpleton, but they have hiked the last two Decembers.  It just seems like a good time to review the year and hike so they don’t get behind.  The ECB may also be tapering some more by then, which could alleviate some yield curve inversion objections.

What does this mean in terms of positioning?  I’m glad you asked.  I have some new trade thoughts.